IBM: Surf's Up! Tide's Out

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Last week, on April 14, 2003, IBM announced its first-quarter results, demonstrating impressive resilience during a period of economic uncertainty. Yet the story behind these numbers tells a tale of continued trepidation in the purchase of IT goods within the marketplace.

IBM says that its diluted earnings per common share increased by 8%, from $.73 per share a year ago to $.79 per share in the first quarter. First-quarter income from continuing operations was $1.4 billion, compared to $1.3 billion last year. Overall revenues grew by 11% to $20.1 billion, compared to $18.0 billion in 2002.

Global Services Stars, DB2 Is Hot, and WebSphere Rules!

Within IBM, Global Services pulled $12 billion in signings. At the same time, IBM Software gained market share, according to IBM, in the areas of database with DB2 and Web application servers with WebSphere.

Meanwhile, according to IBM, the eServer division showed signs of strong growth, led by xSeries. Even pSeries and iSeries showed gains in an otherwise dull hardware marketplace.

All told, it is an impressive first quarter for 2003, especially considering the world's concern about the manufacturing economy, war, and international unrest. But what is particularly interesting is where and how these gains in this quarter were derived by IBM.

The Geographic Growth Curve--Advance Through Weakness

IBM divides its market into three global geographic regions: The Americas (North and South); Europe, the Middle East, and Africa (EMEA); and Asia-Pacific. By understanding how IBM is serving these market areas, we can begin to see how the current global economy is being reflected in its numbers.

IBM says that the greatest percentage of growth in continuing operations occurred in EMEA, up 23% over last year to $6.3 billion. This was followed by Asia-Pacific revenues, which grew at 14% with revenues of $4.5 billion. By comparison, the Americas grew only by 5% to $8.6 billion.

However, much of this growth in percentage appears to have been a result of the weakening exchange rate of the dollar. For instance, the 23% gain IBM notes for EMEA was really only a 3% gain in constant currency. Likewise, Asia-Pacific's percentage gains were only 5% at constant currency. By comparison, the growth in the Americas was actually better than the 5% in constant currency, up by 7% in real dollars.

Hardware Hits Bumps in the Road

One might expect, then, that with a weakening U.S. dollar, the cost of IBM equipment would fall, making it more attractive to customers. However, original equipment manufacturer (OEM) revenues actually fell by 15% (16% at constant currency) to $690 million, compared with the first quarter of 2002. And total hardware revenues from continuing operations were $5.8 billion, a decline of 1% (6% at constant currency), compared with the first quarter of 2002.

Still, according to IBM, revenues from eServer xSeries Intel-based products increased, and revenues grew for both IBM pSeries UNIX-based servers and iSeries midrange servers. IBM says the recently announced p630, with Power4-plus technology, and iSeries servers, with e-business on demand capability, contributed to the overall growth in revenue.

IBM says that revenues from zSeries mainframes were lower in the first quarter because of a combination of customer deferrals of IT decisions and the anticipated introduction of a new zSeries mainframe.

In a similar vein, however, hardware revenues from microelectronics decreased. (IBM says that it was largely related to some non-strategic businesses that it exited last year.) And, year after year, revenues for the personal computer unit declined, consistent with industry trends. Yet, somehow, IBM says its total hardware gross profit margin improved to 26.6% compared with 24.5% in the first quarter of 2002. This may be the result of cost-cutting personnel layoffs and IBM's continued focus on Business Partners' sales during this difficult time.

Software Sustains the Bottom Line

Now compare those patterns in hardware with IBM's revenues in software.

According to IBM, software revenues increased 8% (2% at constant currency) at $3.1 billion compared with the first quarter of 2002. Middleware products, which include WebSphere and DB2 product families, increased 9% (3% at constant currency) in the first quarter of 2003.

Of note too is IBM's recent acquisition of Rational Software during the first quarter for $2.1 billion. IBM says that Rational's post-acquisition profits are included in its first quarter numbers, but it's not clear from IBM's earnings statement if the debt incurred to purchase the company is likewise reflected.

Conclusions: IT Struggles Continue

IBM's earnings during this time of travail are impressive. Yet, because of the weakening U.S. dollar, the gains may reflect some bargain hunting that is occurring in the EMEA and Asia-Pacific regions. The lowered valuation of the U.S. dollar has made IBM products more affordable in countries where IBM has historically been able to charge a premium.

IBM's growth in the services arena, where substantial long-term contracts have been signed, is also an indication that companies are looking to outsource IT services as a cost-control mechanism, instead of bring those services in-house during times of economic uncertainty. IBM claims that this trend reflects the success of its e-business on demand marketing strategy. According to Samuel J. Palmisano, IBM chairman and CEO, "Our results demonstrate that our e-business on demand strategy, which draws on IBM's strengths in business transformation services and open IT infrastructure, is responsive to the needs of our customers."

However, this growth in Services may, in actuality, be a reflection of long-term uncertainty about the global economy.

Likewise, IBM's net increase in software sales may also reflect how the world economy is responding to tough economic times, pulling new software off the shelves or purchasing upgrades to existing software to maximize productivity. It may indicate that there is an excess in hardware capacity that still needs to be overcome within IT. If so, this over-capacity is left from the IT hardware buying sprees of the late 1990s and the lowered business activity of the last three years. Where purchasing of servers has occurred, on the high end of particular server models, it does not necessarily indicate a sudden surge in orders that will lead the IT economy out of its doldrums.

All told, the indications are that IT is still holding its budget very close to the vest, delaying low-end purchases of servers (raising the cost of sales for IT vendors) while relying upon modest purchases of new software to eke out productivity gains. And in this kind of market, IBM is positioned to win: It can make substantial market share gains with its software platforms at modest expense, while shunting off the rise in the cost of hardware sales to its growing legions of Business Partners. Meanwhile, its brand-name visibility makes it look like a bargain in non-U.S. economies as the U.S. dollar weakens, allowing it to, in effect, discount its products without lowing its prices.

But for the IT market as a whole, IBM's Q1 success does not spell the end of the recession. Far from it! According to Palmisano, "Going forward, we are well-positioned to set the agenda and help customers transform their enterprises to realize the benefits, efficiencies, and productivity gains of e-business on demand." But if IBM is focusing on creating an on-demand computing infrastructure, it is doing so because it believes IT's struggle to invest in infrastructure will continue for some time to come.

Perhaps for IBM this means "Surf's up!"

For IT, it means "Tide's out!"

Thomas M. Stockwell is the Editor in Chief of MC Press, LLC. He has written extensively about program development, project management, IT management, and IT consulting and has been a frequent contributor to many midrange periodicals. He has authored numerous white papers for iSeries solutions providers. His most recent consulting assignments have been as a Senior Industry Analyst working with IBM on the iSeries, on the mid-market, and specifically on WebSphere brand positioning. He welcomes your comments about this or other articles and can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..